In 2019, I wrote my first book. My opinion was generally misunderstood at the time, but economic cycles repeat themselves and recent events have confirmed my initial scenario. I estimated that the coming recession would trigger shortages, leading to inflation and resulting in rising interest rates. As we all know, financial instability can arise through the bond market and state financial abuses. Nothing is certain or absolute, but the current market and financial instability warrant a detailed examination of the coming events. Behind the curtain, there is a considerable interest rate trap.
In 2021, for ROCHEGRUP, we discussed the fact that the « economic system is based upon an inoperative monetary destruction. » As a result, “a rise in interest rates could result in deficit restrictions, real estate contraction, bond insolvency, and a financial crisis […] From the end of 2020 until spring 2022 (at least), we will face a major risk. » Although the bond market collapse calmed down at the end of 2022, the effective financial consequences are appearing one year later.
I – Stagflation crisis versus Depression crisis
The bond market crashed last year, and as an immediate result, it broke a 40-year trend of lower interest rates. Long-term US Treasuries lost 30% of their value in 2022, which is the worst figure seen in 250 years. We can’t ignore the fact that this crisis originates more from the macroeconomy than the microeconomy.
Although crises repeat again and again, we usually distinguish between stagflation crises and depression crises. Although both types follow each other over a period of 26 years (read more), it seems obvious that we have entered into a stagflation crisis.
The stagflation crisis is due to the fact that central banks, despite warnings from liberal economists, are trapped. On the one hand, central banks have to raise interest rates to lower inflation. On the other hand, they have to ensure financial stability, which is currently contradictory with the current balance sheet of all banks and financial institutions.
From our point of view, history provides a clear insight. A stagflation crisis erupted in the US, especially after the end of World War I, and prices rose dramatically above 15% between 1917 and 1920. The following graph shows the inflation crisis (red) as well as the following depression and deflation (yellow). We can see clearly that the market crashed by more than 30% in 1917, before recovering and testing new highs at the end of 1918. In the meantime, the Fed raised interest rates from 1917 to 1920. As a result, the Dow Jones peaked in 1920 before going back to the previous lows. The number of banks in the US peaked in 1920, with an estimated peak of 30,000 banks.
1920 was the peak of the inflation crisis, after which a depression followed. Additionally, the Fed raised interest rates from 4.5% in 1919 to 7% in 1920. Such an increase does not make sense with today’s situation. Finally, please note that the first graph shows three Kitchin cycles (approximately 3.3 years).
But what is most impressive is the historical cyclical concordance. The next graph highlights how regular cycles are. It shows the value of Dow Jones (x10) between 1915 and 1925 in black, and the value of Dow Jones between 1967 and 1977. Stagflation periods are a component of the Kondratiev cycle (with a theoretical period of 13 years).
Note that a divergence appears after 1977 in the historical behaviour of the Dow Jones (with more Kondratiev transitions). Therefore, as of today, we could be around 1970/1971 if we compare to the Kondratiev cycle, which also shows similarities with the current financial market behaviour. However, a more detailed comparison is needed. Finally, a study of the Kitchin cycle could indicate a potential stabilization around mid-2023 (considering both the 2018 low and 2020 low).
II – Economic prospects
Furthermore, stagflations often occur at the top of the Kondratiev cycle, resulting in greater amplitude of economic growth and financial factors such as Dow Jones. This explains why the Kitchin cycle is more visible during stagflations and why Dow Jones exhibits similar behaviour across decades.
In the following table, we have listed every recession in the US since the beginning of the last major Kondratiev cycle (48 to 60 years cycle). When the period between two recessions is unusually long, it often signals a significant shift in growth and price rhythms. Since 1949, the average period between two recessions has been 6.6 years (which means two Kitchin cycles). Furthermore, the average duration between two Juglar cycles is 10.14 years. Recently, the duration between the 2009 recession and 2020 was 10.75 years, which is a record! Inflation was also announced.
ECONOMIC CYCLE FOR THE UNITED STATES
Data source, FRED
|High economic growth point
|Duration (years, lowest)
|Juglar cycle duration
Legitimately, we can hope that the next recession should occur around 2026 in the US. Of course, it can come quicker, but actually, timing is not completely favourable for a recession today. Credit expansion among household sustain demand, and this mechanism could be tackled. The next question comes with the amplitude of this recession. We saw that 1921 was a major depression and it bucked the trend of higher inflation. Then it lasted into the Great Depression. On the other side, the 1970s and 1980s show numerous recessions more frequent than depressive.
As a result, if we consider that inflation will be durable (given by the fact that real interest rate is significantly negative), recessions could be more frequent than intensive as well. On the opposite, a strong recession could occur at the end of this inflation crisis (more short than durable).
III – Long term trap of Interest Rate
Negative real interest rates can threaten economic stability by enabling governments to borrow while relying on revenue growth from inflation. This means that debt is essentially free.
As we have seen, rising interest rates can create financial instability in the medium term, as banks and financial markets rely heavily on debt and bonds. Not only does rising interest rates lead to lower financial performance, but it also weakens the overall solvency of the financial system.
However, the main issue will likely come in the long term. There is currently no plan for addressing rising interest rates on public debt. For example, if the average interest rate paid by the French government is 3%, interest charges could exceed 100 billion euros by 2027, which is 4% of GDP and the largest budget item. Structural deficits are already too high, and rising interest rates will add a considerable burden to government budgets. It is likely too late for governments to address their public debt in a meaningful way, as they have been growing their debt for over 40 years with the help of low interest rates. While negative (real) interest rates have provided an opportunity to continue this trend in recent years, the risks were known and we are now facing a bleak future.
Nikolai Kondratiev would have reminded us better than anyone why inflation produces more revolutions in the cycle than during usual times. Debt is a burden, and inflation doesn’t necessarily reduce it. When debt is structural and credit is reduced, the system can only go bankrupt. The long-term trap of interest rates will come slowly, and we expect major budget difficulties to arise gradually in the next 3 to 5 years at least (the average public debt maturity is around 8 years).
We are entering a vicious cycle of higher inflation, liquidity crisis, and lower growth, and there is a real and significant impact on financial markets. Stagnations often last for a decade.
IV – The gold advantage
Gold appears to be one of the greatest assets in this times. Because financial market performance is not ensured, investors could have an interest for this relic.
Indeed, the price of gold is not solely determined by demand. In the long term, we can observe that the production cost, just like for Bitcoin, is a key factor that determines the fundamental price of gold. Recently, nearly 10% of the overall gold mining production (which accounts for 80% of the supply) was not profitable. While bankruptcies have driven some demand for gold, it is also fundamentally favorable. New highs could be reached, and UBS projects a gold price of $2,100 in 2023.
From a technical standpoint, a very bullish trend could lead to a gold price of $2,300 in 2024 or 2025 (which is also the top of the Pi cycle). Various factors could contribute to this trend, including interest rate stabilization, mining cycle, bank failures, abnormal central bank demand, and real interest rates.
Article written by Economist Thomas Andrieu for ROCHEGRUP